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Friday, December 11, 2009

On Economists and Band-Aids

I would like to attempt to answer Mike's charge (which I agree with) that economists tend to apply simplistic band-aid-like solutions to complex problems. I would argue that a carbon tax is one such overly simple solutions: Is there a social cost to pollution? "Tax it!" say (some)economists. Is there a social benefit to health care? "Subsidize it!" say (some) economists.

Of course the reason many economists are attracted to simple solutions is because 'simple' is the only course of actions their mathematical models allow. When you try to box your science into modelling all behavior as a system of digits, then the only answers you can provide will consist of the same system of digits. It is this failure of the science to incorporate a more holistic method of analysis that begets the simplicity - and why all mainstream economic analysis needs to be tempered with reality checks.

9 comments:

Only academics, particularly in the social sciences can make a nice living while contributing so little to society.

I have economic solution to this problem: Set up a fund where awards are given to those who can solve the society's most pressing problems. That way it will encourage competition, the most realistic model will win, society is better off. The only catch is once a solution is found, it must be open source.

You will have a problem though of economics being a lot about politics. Deflate the economy and you hurt borrowers help lenders. Inflate the economy and you help borrowers hurt lenders. Exchange rate falls and you help exporters but hurt consumers of imports. Exchange rate rises, well you get the idea. So much of economics is about power struggles, fairness and competing goals. Therefore to get the award economists need to have the goals spelled out for them.

Have to slightly dissent here. The reason for supporting taxing isn't because it "is the only course of actions their mathematical models allow." It's because it's the most direct way to change incentives measurably.

The problem isn't simple models; most economists know the models are simple. The problem is that the model is only as useful as the choice of what is being measured.

To take the example (identity) from comments to your Classroom post:

(S-I) = (G-T) + (X-Im)

S-I is supposed to equal zero. Any savings is by definition invested. (There are no mattresses in economic theory.) Similarly, G-T is supposed to equal zero (we pay for Government to the limit of what we want Government to do). And (X-Im) is, by definition, zero on a worldwide basis.

So if (G-T) locally is negative, and (X-Im) locally is negative, then (S-I) locally must be negative—that is, there is more Investment in the local area than there is Savings.

Clearly, I and S need to be better determined (broken down further). Which requires more detailed measurement than the Econ 101 example.

The reason we still celebrate Simon Kuznets isn't for his eponymous curve, but rather that he convinced people that it was worth doing more detailed measurement of the national accounts. Using more details, for instance, you get Bernanke's papers (book) on The Great Depression.

The problem is the detail of measurement available and the detail shown are often not the same. (The accounting equivalent is to think of S, I, etc. as General Ledger entries with their own subledgers.)

So the solution on the G/L level is to change the incentives by taxation; the detail of that taxation (subledger entries) is where to determine actual policy.

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Garth Brazelton

About Me

I work for the Indiana Economic Development Corporation as the Director of Operations and Business Systems, and I teach macroeconomics at Indiana University (Indianapolis). Previously, I was an Economist at the US DOT in Cambridge, MA. This blog does not represent the opinions of any of these organizations.